Tuesday, May 31, 2005

Real estate prices have gone through the roof, and they are still climbing. Many say the end is near and the "Sky is about to fall". Peter Pike noted the following in the Pike Net Dispatch

Hot, Hot, Hot... "Real Estate Gold Rush," Fortune's recent cover blares out. "Riding the Boom," its feature story, is sub-headlined,"They snap up real estate, flip it, then chase the next hot market. They're the new day traders -- and they're dancing on the edge of a volcano." (May 30, 2005)

Housing prices are up an average of 50% over the past five years. "Economists say today's debt-fueled investment binge in real estate is fanning the flames of an already overheated housing market..." (Wall Street Journal, May 23, 2005)

Whoa. Do you hear echoes of the dot-com bubble bursting? Last year interest-only loans accounted for 31% of all U.S. mortgages (up from 1.6% in 2001). In some markets it's even higher, accounting for two-thirds of all loans in the San Francisco Bay Area, warns Thomas Sowell. (Wall Street Journal, May 26, 2005)

"The value of a house, like the value of any other asset, depends on its prospects -- and those prospects obviously look better before a bubble bursts. ... How much of a decline and how far the repercussions extend, if and when the bubble bursts, is the big question."

Remember Alan Greenspan warning about "irrational exuberance" in the stock market in 1996? Here's Greenspan now speaking in a similar code about the housing market, "Without calling the overall national issue a bubble, it's pretty clear that it's an unsustainable underlying pattern.'' (New York Times, May 21, 2005)

So if current levels of price appreciation are "unsustainable" and the bubble bursts, will it affect commercial real estate? How are you preparing for it?

Even if housing prices do fall, the drop won't hit most homeowners hard because of the huge amount of equity already in their homes, Greenspan told more than 1,000 onlookers at a meeting of the New York Economic Club.

"There are a number of things which I think suggest, at minimum, that there's a little froth in this market," Greenspan said, to laughs from those thinking that might be an understatement.

The Fed chairman argued that while there isn't a national housing bubble, many regional high-priced pockets exist. "It's pretty clear that it's an unsustainable, underlying pattern," he said.

Monday, May 23, 2005

An important mortgage market player has sounded an alarm about limited-doc and interest-only features in a growing percentage of home loans, especially those made to purchasers with subprime credit.

In an advisory issued last week, Wall Street's Dominion Bond Rating Service, which assigns risk ratings to mortgage-backed securities pools, expressed "concern" about lenders' potential "easing of credit standards" to boost origination volumes in the post-refi boom climate of 2005.The rating agency cited interest-only and "stated documentation" loans in new subprime mortgage pools as especially worrisome. "Stated" doc mortgages generally do not require homebuyers to provide hard evidence of income and assets to support their applications. Interest-only loans allow home buyers reduced monthly payments -- there is no principal reduction for an agreed-upon initial period -- but then convert to full amortization for the balance of the term.

Dominion said "mortgages underwritten (with) minimal documentation sometimes account for as much as 50 percent of mortgage pools" in the subprime arena. Yet the no-doc/stated-income concept was originally designed to assist self-employed, business-owning homebuyers with solid credit histories who preferred not to divulge their full financial details. The idea was not designed for buyers with marginal incomes and credit.

No-doc "has since been expanded to include salaried borrowers who cannot or will not show proof of income," said Dominion in its advisory. Some analysts have called such mortgages "liar loans" because the income or assets claimed by the applicant may be illusory or fraudulent. That potential, in turn, raises the chance of future delinquencies and foreclosures.

Dominion is hardly alone in its opinions. Last spring, two major mortgage insurance companies blew the whistle on "NINAs" -- no income, no asset verification loans -- and curtailed issuance of new insurance to no-doc borrowers with low downpayments.

"It may be stating the obvious," said Curt Culver, president and CEO of Mortgage Guaranty Insurance Corp. (MGIC), the largest underwriter in the industry, "but you can't document what you don't have. In many instances (NINAs) are allowing borrowers to do just that. Why wouldn't a borrower choose to fully document their income to assure that they get the lowest possible rate?"

Another insurer, United Guaranty, stopped underwriting non-docs after investigators found that in 90 percent of NINAs that defaulted, mortgage or realty professionals working with the home buyers knew in advance they really didn't have the income or assets necessary to afford the house.

Dominion's concerns about interest-only subprime loans centered around the fact that the industry has "only a limited performance history" on this breed of mortgage. Other analysts have pointed out that interest-only mortgages have a heightened propensity to default because of possible "payment shocks" after the initial low-payment period expired.

For example, say a home buyer takes out a 30-year $333,700 hybrid ARM with an interest-only period of five years. The lender sets the initial fixed payment rate at 5.25 percent -- or $1,460 a month. But in the 61st month, the loan morphs into a one-year LIBOR-indexed adjustable with a standard 2.25 percent margin. With the onset of principal reduction, plus a compressed 25-year remaining amortization term, the monthly payment due from the homeowner would shoot up by 30 percent overnight -- to $1,895 -- if market rates remained flat. But if rates in the economy overall rose by just 1.5 points during the five-year period -- a scenario not unlike what could happen under current Federal Reserve monetary policies -- the payment due in the 61st month would jump by 50 percent to nearly $2,200 a month. That might well be too great a jolt for the homeowners to handle.

The bottom line for realty and loan professionals: Tempting though it may be to "make the deal go through" with the help of short-term payment reduction techniques such stated-income and interest-only, the long-term result for home buyers with subprime credit could prove disastrous -- loss of their home to foreclosure.

Sunday, May 22, 2005

Bob Bruss reviews this book and says, if it doesn't boost property value, don't do it If you are considering remodeling your home, but you are a little intimidated by the process, reading "What No One Ever Tells You About Renovating Your Home" by Alan J. Heavens will explain the "dos" and "don'ts" for a successful project.

This is not a "how to" book explaining specific tasks, such as installing dry wall. There are lots of other books explaining home remodeling components. Instead, this book takes an overall view of home renovation, explaining when it is wise and when it shouldn't be undertaken.

In a likeable, self-deprecating way, home remodeling expert Heavens shares many of his personal home renovation experiences, mostly to illustrate what not to do. For example, he explains his misplaced obsession with finishing his basement remodel before he completed his more visible and partially completed upstairs fix-up projects.

The book is filled with lots of real-world examples from homeowners who undertook home renovation work, mostly successful, but a few with unplanned results. The story I liked best is about Alex and Beth Cerrato from San Diego who added a 1,500-square-foot addition while continuing to live in their home with their 18-month-old son. That must have been fun. They explain how they hired a recommended remodeling contractor who actually completed the project on budget and delivered top quality work.

Saturday, May 21, 2005

Wright Plus 2005 will be held today from 9am to 5pm in Oak Park, Illinois. On the house tour will be nine private homes, four of these were designed by Wright. Also included will be public buildings, the Frank Lloyd Wright Home & Studio, Unity Temple and the Robie House in Chicago. Tickets cost $70.00 for a Preservation Trust member and $85.00 for non-members. You can purchase tickets on-line at www.wrightplus.org or at the Ginkgo Tree Bookshop at 951 Chicago Avenue in Oak Park.

The recent rise in rates has reversed, and then some. The 10-year T-note was sub-4.15 percent Friday, flirting with a break below 4 percent, and 30-year fixed-rate mortgages can be found as low as 5.625 percent without fees.

Nobody with good sense knows for sure why long-term rates have broken down (of course, that "good sense" qualifier dismisses a majority of those trading bonds).

For sure, long-term rates have decoupled from economic fundamentals. Rates have been falling for six weeks on the theory that the economy is slowing down, but the newest data says no, not hardly. April retail sales doubled the forecast, and first-quarter GDP growth will soon be revised from 3.1 percent and shaky to close to 4 percent.

In another decoupling, bonds used to improve when oil prices rose, on the theory that high prices would slow the economy, or resulting inflation would force the Fed to slow it down. Oil is down to $48/bbl today, and accumulating inventory and reduced consumption in the United States and China portend a further price decline.

The consensus Fed forecast is still the same: another .25 percent on June 30 and Aug. 9, and a stop at 3.5 percent. Doesn't make good sense to me: the long-rate rally is adding stimulus that the Fed is trying to remove. Why would the Fed stop short?

Monday, May 16, 2005

Builder confidence rose slightly this month, up three points to 70 on a seasonally adjusted annual basis, according to the National Association of Home Builders/Wells Fargo Housing Market Index released today.

Builders have maintained a confidence range between 67-71 for over a year, aided by buyer demand for new single-family homes, continued low mortgage rates and an improving job market, the association reported.

The index is derived from a monthly survey of builders that NAHB has been conducting for about 20 years. Each month, builders report current sales of single-family homes and prospects for sales in the next six months as either “good,” “fair” or “poor.” They also rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view sales conditions as good than poor.

Builders rated the present state of single-family sales at 76 in May, the next six months in single-family sales as 77, and the traffic of prospective buyers at 53.

The component index gauging current single-family sales rose three points to 76 while the component index gauging sales expectations for the next six months and the component gauging traffic of prospective buyers were 77 and 53, respectively.

“Builders have seen an up-tick in traffic and sales brought on by improving economic conditions and mortgage rates that continue to remain at affordable levels. They have confidence in the overall housing market and expect sales to stay strong for the next six months,” said NAHB President Dave Wilson, a custom homebuilder from Ketchum, Idaho.

“Builders obviously continue to see strong buyer demand for single-family homes,” said NAHB Chief Economist David Seiders. “With unsold inventories in good shape, housing starts should be solid in coming months.”

The NAHB/Wells Fargo Housing Market Index is solely the product of the home builders' association and is not influenced by any other party. HMI historical information and tables are available online at: http://www.nahb.org/hmi.

Wednesday, May 04, 2005

The Federal Reserve today decided to raise its target for the federal funds rate by 25 basis points to 3 percent, saying pressures on inflation have picked up in recent months.

In a statement from the Federal Open Market Committee, the Fed said its stance of monetary policy remains accommodative, and "coupled with robust underlying growth in productivity, is providing ongoing support to economic activity."

Rates on long-term mortgages so far have not followed suit. Most economists, however, predict a gradual rise in rates over the course of the year.

The Fed also said today that "recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually. Pressures on inflation have picked up in recent months and pricing power is more evident. Longer-term inflation expectations remain well contained."

Monday, May 02, 2005

All long-term rates fell again late last week. The benchmark 10-year T-note has broken below 4.2 percent, and an "origination fee" will buy a 5.5 percent 30-year fixed-rate mortgage.

Bond traders are placing recession bets. Not (yet) in expectation of a classic recession in which GDP growth would decline, but a "growth recession" in which GDP growth might slip to 1 percent or 2 percent annual, and the unemployment rate begins to increase. The rationale for a recession bet is this win-win equation: either high energy prices and a tightening Fed have already tipped over the economy, or a worsening inflation problem will force a tighter Fed and tip-over at a later date.

Evidence. Last week's breakthrough bond rally started with news of a steep drop in March orders for durable goods, and gained steam on Thursday's news that first-quarter GDP had grown only 3.1 percent. That's fabulous by European or Japanese standards, but not enough to support U.S. job growth. Internal aspects of the report were worse: "final demand" (purchases by business, government, and individuals) rose only 1.9 percent. The excess of 3.1 percent production over 1.9 percent demand is sitting on shelves and floors as unsold inventory, a disincentive to production in this quarter.

Second, the personal consumption expenditure deflator ("PCE"), used to convert nominal GDP to after-inflation, jumped to an annual 2.2 percent gain. The PCE is Federal Reserve Chairman Alan Greenspan's favorite, and the acceptable band for its movement is 1.5 percent-2 percent; if PCE is in a jailbreak, the Fed is coming no matter what collateral damage its inflation-fighting may (will) do to the rest of the economy.